The impact for law firms of rising interest rates
Robert Blech · Posted on: April 22nd 2025 · read
This article was first published in Legal Compliance magazine, published by the Law Society.
About 2 years ago, I was having discussions with those in the legal profession about the prospect of negative interest rates on law firms holding client money and whether a cost would have to be levied upon clients for holding their money.
However, the world and national economic climate has caused a rapid change in the opposite direction. Inflation steadily rose and interest rates began to go up. At the time of writing, current rates are 4.5% and inflation is at 3%, still above the Bank of England target of 2%.
Interest rate increases can have a significant impact on cash flow and profit. Repayments may increase on borrowings and commercial loans. Borrowings have been low for so long that the impact on businesses of an interest rate rise can be damning. Firms may take out loans for PI insurance or tax liabilities. Borrowing was cheap, but not anymore – well compared to recent years anyway.
The impact on staff of interest rate rises has meant that mortgage repayments may go up, and inflationary pressures cause prices of everyday goods to increase. This results in staff asking for pay rises as their income in real terms falls. In addition to this, the proposed rise in National Insurance announced in the budget last year places an extra burden on law firms.
For legal practices, as well as the commercial aspects of interest rate rises, there are the regulatory requirements to consider. Rule 7.1 of the SRA Accounts Rule 2019. “You account to clients or third parties for a fair sum of interest on any client money held by you on their behalf”. There is often debate as to what the term “fair sum” means in respect to how much interest law firms are meant to pay out.
A significant number of practices will have a de minimis amount below which interest will not be paid to clients. Such a policy will usually be mentioned in the client care letter or terms of engagement. It is important that this is regularly reviewed to make sure it remains “fair.” Accounting systems should have controls in place which alerts users as to when interest becomes payable to clients. Without this, the firm will not know when interest is due according to their policy and may be in breach of Rule 7.1.
There is the option of some flexibility in Rule 7.2 which states “You may by a written agreement come to a different arrangement with the client or the third party for whom the money is held as to the payment of interest, but you must provide sufficient information to enable them to give informed consent”. To utilise this rule however, it is crucial that “sufficient information” is given so the client can decide whether or not to consent.
"In the recent Consumer Protection Review to which responses closed in February, there were a number of questions raised around interest rates. These included asking firms whether their clients are aware that the practice may retain some of the interest earned on their money and whether the SRA should amend their rules to prevent retention of interest (subject to a de minimis). If the SRA were to introduce a ban on firms retaining interest above a minimum amount, this should be introduced gradually to mitigate any cash flow issues for firms."
Whether it is appropriate or not, rising interest rates have certainly seen firms take advantage of it. Reviewing sets of accounts, it seems in some cases there is a growing disparity between the amount received and paid out and compliance with Rule 7.1. If firms are relying on receiving this interest to make a profit or deal with a cash flow shortage, this will be of serious concern and practices should be mindful of the SRA’s position. In the Consumer Protection Review the SRA state “We are yet to hear compelling evidence of how firms retaining any interest is in the consumer's interest”.
One thing is for certain, we will not be having a conversation about negative interest rates any time soon.
